Spotlight on service charge

Spotlight on service charge

In this item we look at recent developments in the area of service charge including a case on the recovery of residential service charge for a period before the landlord acquired its interest, a case highlighting the importance of clear drafting for commercial service charge reserve funds and a reminder of the launch of the 3rd edition of the commercial service charge code.

Original news—residential service charges

Ground rents (Regisport) v Dowlen [2014] UKUT 0144 (LC)

This case involved a large bill for the supply of water to three blocks of flats. The bill, which exceeded £65,000, related to water supplied to the three blocks between June 2005 and April 2011. It built up because for many years Thames Water delivered invoices for water consumed at two of the blocks to the developer originally responsible for their construction while the landlord, which acquired the freehold of the three blocks on 1 October 2006, received invoices only for the third block.

The landlord’s managing agents, in the mistaken belief that the invoices they received related to all three blocks, apportioned those sums and collected them through the service charges payable by all 164 tenants of flats in the three blocks. The developer did not pay the invoices it received for the other two blocks, nor did it pass them on to the landlord. Both the landlord and the tenants believed all of the sums due had been paid. The mistake was eventually discovered in 2010 and since then Thames Water had sought to recover the arrears from the developer and from the landlord, which in its turn had sought to pass them on in full to its 164 tenants.

An associated company of the developer had entered into a common billing agreement with Thames Water for a bulk metered water supply to be provided to all three blocks making it responsible for all charges for water and sewage services supplied to the blocks. Under the agreement it could not assign the benefit of the agreement without first obtaining the written consent of Thames Water. When the developer transferred its interest in the three flats to the landlord it had not assigned the benefit of the agreement, nor asked Thames Water for its consent to such an assignment.

What does the legislation provide?

The Landlord and Tenant Act 1985, s 20B(1) (LTA 1985) provides that tenants under long leases of dwellings are not liable to pay service charge to the extent the costs were incurred more than 18 months before the demand is made.

On that basis, the Leasehold Valuation Tribunal (LVT) had decided that the tenants were not liable to contribute to the historic water bill through their service charge to the extent that the water invoices had first been raised before 30 January 2009. The LVT reached that decision because the landlord had first included the arrears of water charges in the service charges demanded in June 2010.

The landlord appealed the decision of the LVT on the grounds that the disputed water charges were only ‘incurred’ by it when it was first sent an invoice for those charges by Thames Water around May 2010. It argued that the fact that invoices for the same charges had been sent to the landlord’s predecessor was of no significance when applying the 18 month limitation period.

The Upper Tribunal (Lands Chamber) agreed, allowing the landlord’s appeal.

Why did the Tribunal allow the appeal?

'Costs incurred'

In Burr, the Court of Appeal confirmed that although a liability to pay for a service, such as the supply of gas or water, may exist when the service is provided, that liability does not give rise to an incurred cost for the purpose of LTA 1985, s 20B until it is quantified or crystallised by the presentation of an invoice or the making of a payment. The 18 months runs from when the cost, not the liability, is incurred.

The landlord for the time being

The LVT had been correct in confirming this and was also correct when it confirmed that costs are incurred when the invoice is first presented for payment ‘…to the landlord for the time being…’ to complete its statement of the appropriate test.

The Tribunal confirmed LTA 1985, s 20B is concerned with ‘relevant costs’ to be taken into account in determining the amount of a service charge and LTA 1985, s 18(1) confirms ‘relevant costs’ are costs or estimated costs incurred or to be incurred on behalf of the landlord or a superior landlord. Costs incurred by a former landlord in respect of a period after it ceased to be landlord are not relevant costs, unless they are costs for which the landlord for the time being is also liable in its own right.

Where successive landlords are liable for the same costs (as could be the case here, as the developer’s liability under the common billing agreement may coexist with a liability to pay (not yet established) on the part of the landlord under the Water Industry Act 1991 (WIA 1991)) it is the liability of the landlord for the time being which is material since only costs incurred by a person in the capacity of landlord may be included in the service charge.

The invoices addressed to the developer after 1 October 2006, when it ceased to be the landlord for the time being, were its contractual liability—they did not give rise to any liability on the part of the landlord. No claim for payment was addressed by Thames Water to the landlord until April 2010, nor was any claim for an indemnity made by the developer against the landlord, whether under the terms of the original contract of sale or on restitutionary principles. WIA 1991, s 142 does not create a liability to pay for water until a demand is received by the occupier. For the purposes of LTA 1985, s 20B no relevant cost was incurred by it until it received the first demands for payment in April and June 2010 for the two blocks for which it had not previously been invoiced.

It was not clear from the LVT’s reasoning why it reached the opposite conclusion. The 18 month rule was designed to ensure a tenant is not faced with a bill for expenditure of which he or she was not sufficiently warned to set aside provision. However, the extent of that protection was that the leaseholder is not liable to pay so much of a service charge as reflects costs incurred more than 18 months after an invoice is presented or payment is made by the landlord or management company. It was immaterial, for the purpose of LTA 1985, s 20B, whether any party was at fault for the delay in presentation or payment of the invoice (the LVT had found that the landlord was at fault in not realising something was amiss).

Was the landlord entitled to adjust the service charge?

The form of lease provided that a certificate signed by the landlord and purporting to show the amount of the service charge or the amount of balancing payment to be made by the tenant (service charge adjustment) for any service charge year was conclusive except for manifest errors.

However, the service charge adjustment was the amount by which the estimate of expenditure likely to be incurred in a particular service charge year fell short of the actual expenditure in the service charge year. Before June 2010 there was no actual expenditure on the supply of water to the two blocks for which the landlord had not been billed. A certificate given by the landlord purporting to record expenditure on water and sewage charges for the year ending 30 June 2010 might be conclusive of the amounts actually expended in that year (save as regards manifest errors), but that would not prevent the inclusion in a certificate for a future year of expenditure in that future year which related to the water supplied in a previous year.

Therefore, it was open to the landlord, when calculating and certifying the service charge adjustment for the year ending 30 June 2011 and for subsequent years, to include expenditure actually incurred in those years in discharging any liability which the landlord had for water supplied in the period from 1 October 2006 until it began to receive demands in its own right in April and June 2010.

What are the practical implications of the decision?

In Burr, the Court of Appeal noted the practical relevance of LTA 1985, s 20B may be somewhat limited as most modern leases give the landlord/management company the right to require the tenant to pay a service charge in respect of estimated costs to be incurred. Many landlords therefore make a service charge demand based on an estimate, rather than waiting until a demand for payment is made of them.

The Tribunal’s decision in this case will give comfort to landlords in instances such as these, where a mistake arises so that it is not aware of its liability as it is not invoiced for a particular utility (here water) until years later.

For further information on residential service charges see our Practice Note: Residential—statutory limitations on recovery of service charges and administration charges.

Original news—commercial service charges

Friends Life Management Services v A & A Express Building [2014] EWHC 1463 (Ch)

Friends Life involved a dispute about service charge sums collected under a commercial lease as a provision for future expenditure on major works. The tenant exercised its break clause at which point those major works had not been carried out. They were begun after the lease ended on 24 March 2010 and then they were carried out later in 2010 and continued into 2011. The tenant's principal claim related to the computation of the service charge for the last accounting period under the lease.

What were the key issues involved?

The case turned on the lease wording and the court’s findings included confirmation that:

  • notwithstanding that the lease ended on 24 March 2010, the relevant accounting period was the period to 31 December 2010
  • the parties had agreed that it was not possible to include a provision for expenditure which would not be incurred during the contractual term or during the last accounting period under the lease. The same applied where the lease was broken. It was not possible to distinguish between a case where the lease ends by effluxion of time and a case where the lease ends pursuant to the tenant's break right. This is in line with the decision in Brown's Operating System Services. This was certainly the case where the relevant account for the period to 31 December 2010, was prepared when it is was known that the term of the lease had previously ended on 24 March 2010. Therefore, only the cost of the major works carried out in 2010 should have been included for the account prepared for the year to 31 December 2010
  • however, credit should have been given, in the account to 31 December 2010, for the whole of the provision of £875,000 which had been charged in relation to anticipated expenditure for the major works—and collected by the landlord (ie full credit should have been given for the sums collected to date)

What are the lessons for lawyers?

The High Court set out in detail, the service charge computations which should have been carried out, on its interpretation of the lease. The cost of the proceedings could no doubt have been avoided had the parties considered and agreed the impact of the break clause on the service charge provisions in the first instance and ensured that the wording of the lease clearly reflected this.

For further information on reserve and sinking funds see:

  1. Commercial service charges—what expenses can the landlord recover?
  2. Lease clauses for a sinking fund

  3. Lease clauses for a reserve fund

Original news—Service Charge Code

The third edition of the Service Charge Code (the Code) was launched on 4 February 2014.

Some of the key differences between 2nd and 3rd editions of the Code are:

  • the RICS information paper 'Service charges and tenant alterations' has been summarised and incorporated into the Code
  • in conjunction with the release of the new ICAEW technical guidance on accounting for commercial service charges, RICS has issued a sample report on service charge accounting. This is contained in Appendix C of the Code and recommends best practice for disclosure and the provision of information by managers to accountants, and then communication with tenants
  • the RICS information paper 'Sinking funds, reserve funds and depreciation charges' has been summarised and incorporated into the Code, including a refinement of the description of such funds
  • additional guidance is now provided in relation to green leases, the Carbon Reduction Commitment Energy Efficiency Scheme (CRC), improving environmental performance and Energy Performance Certificates (EPCs)

What is also notable in the new 3rd edition is the change in language in respect of some of the core principles. RICS acknowledges that a number of changes have been made to correct grammatical errors and to improve the consistency of wording. Arguably, however, the effect of such changes is to further dilute the impact of some of the core principles with managers only being 'advised to' or 'expected to' rather than 'must' or 'will'.

For further information see:

  1. Commercial service charges—the importance of following procedures
  2. Challenging commercial service charges—checklist

This article was written by Joanna Bhatia, solicitor in the Lexis®PSL Property team and was first published in LexisPSL Property on 13 May 2014. Click here for a free one week trial of Lexis®PSL Property.  

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About the author:
Joanna is a commercial property specialist. Prior to joining the LexisPSL Property team, she was a transactional lawyer. She qualified in 1995 at Shoosmiths and subsequently worked at Nabarro, Charles Russell, Bircham Dyson Bell and Pemberton Greenish. She has wide-ranging experience of all non-contentious property transactions, with a particular emphasis on landlord and tenant work.